QE, like a water spigot, can vary in force

Investors should try to get used to the idea that the Federal Reserve’s quantitative easing program may work like a water spigot, with the central bank turning up or down the pace of purchases depending on the incoming information, but without shutting off the faucet completely.

At the moment, the Fed is talking about turning down or “tapering” the pace of the the asset purchases. According to the Wall Street Journal Monday, John Williams, the president of the San Francisco Federal Reserve believes this idea makes sense.

The Journal report also said that Fed officials are mulling a rethink of their June 2011 “exit strategy.” The strategy calls for the Fed to first start raising interest rates and then selling mortgage-related assets on its balance sheet, returning to the historical norm of keeping only Treasurys.

No formal review has started, the story said. At the moment, there seem to be as many opinions about the Fed’s exit strategy as there are Fed watchers.One idea gaining favor is the Fed holding its mortgage-related securities to maturity. This kills two birds with one stone: the Fed avoids losses on its balance sheet which may distress Congress and avoids potential market disruption.

With the Fed saying that it plans to hold policy steady at least until the unemployment rate dips below 6.5%, there should be some time before the strategy needs to be nailed down.

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